The European Central Bank (ECB) has followed up on earlier plans, reported by the European Conservative, and raised the interest rate on Thursday, September 8th, by 75 basis points, putting the benchmark deposit rate at 0.75%. The unsurprising raise, the second this year following an earlier hike in July, is aimed at combating the soaring inflation rate. Unwilling to stop there, the ECB announced in a statement that it “expects to raise interest rates further, because inflation remains far too high and is likely to stay above target for an extended period.”
After an initial hit, stock markets reacted slightly positive to the decision. The pan-European Stoxx 600 was up 1.5% on Thursday afternoon, while basic resources ended 4.3% higher, and banks were up by 2.3%.
The president of the ECB, Christine Lagarde, admitted in a press conference that while “energy is the major source of inflation, along with the increase in food, we also have inflation spreading across a range of products and services where demand plays a role,” adding that “in the face of inflation that is extremely high … of a magnitude and persistence across sectors of that nature, determined action had to be taken.”
The ECB has also revised its prognosis for the further development of inflation, forecasting now an average of 8.1% in 2022, 5.5% in 2023, and 2.3% in 2024. Future hikes of the interest rate will be necessary to return inflation to its 2% medium-term target.
According to Bloomberg, it was the U.S. Federal Reserve’s “hawkish mantra” that forced the ECB’s hand in this instance. Fed Chair Jerome Powell similarly announced on Thursday that “history cautions strongly against prematurely loosening policy,” adding that he and his colleagues are “strongly committed to this project and will keep at it until the job is done.”
Economic forecasts by the ECB see the EU bloc’s growth potential between 2.9% and 3.1% GDP growth in 2022, between 0.9% contraction and 0.9% growth in 2023, and at 1.9% growth for 2024, avoiding a recession in all but the worst case scenarios. The HSBC global chief investment officer Willem Sels noted that central banks “have been torn between the need to crush inflation, and their realization that recession risks continue to increase.”
However, “the rate hikes will further raise borrowing costs of peripheral countries and tighten financial conditions,” said Sels, “which may deepen the recession.” While the current rate of 0.75% is still below the so-called “neutral” rate between 1% and 2%, Konstantin Veit, portfolio manager at investment firm Pimco, said that a move into neutral territory before the end of the year would be considered “uncontroversial.” For him, the “more interesting” question was what the “terminal rate,” referring to the highest point of the rate, would become during this hike cycle.